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Narrow focus by MPC on unemployment could abort the recovery

The UK economy was expected to grow more quickly than before but there was the risk that the Bank of England might abort the recovery before it has reached escape velocity, if it maintains its focus on employment even as real wages continued to fall.

Those were the main conclusions to be drawn from the Ernst&Young ITEM Club's Winter economic forecasts.

The consultancy's economists now project growth in Britain's gross domestic product to reach 2.7% in 2014, followed by an expansion of 2.4% in 2015.

However, one should not assume that "the good times are back"; things are more complex.

The proof was in how the current growth profile was lopsided in two ways, they explained.

For one, the economy was being driven almost exclusively by consumer spending and housing. Yet increased business confidence had to date not been matched by an improvement in investment and exports. Hence, the upturn was neither balanced nor sustainable.

Secondly, despite rising employment real wages were continuing to fall, with the resulting gap reflecting a number of structural shifts in the work force - although it was expected to close by the beginning of 2015.

All of the above presents the Bank of England's Monetary Policy Committee (MPC) with a dilemma, as the dynamics mean that the unemployment rate alone is too blunt a reference when trying to gauge when to start raising interest rates.

"Instead, the MPC must hold interest rates steady until real wages and business investment were rising. Otherwise it risks aborting the recovery before it reaches escape velocity," E&Y said.

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